The Internet of Things: The Rise of the Machines Is Here

You’ve just settled into your seat in a jetliner when the pilot announces a mechanical delay. Unfortunately, this is not an uncommon experience. But it could become a rarity before long, as jet engines and other moving parts are increasingly wired with technology that can diagnose problems before they occur.

This scenario is just one example of the promise offered by the “Internet of Things.” As the world around us becomes increasingly connected for communication, it’s becoming much more common for devices to talk to each other. This is ushering in a new level of awareness that promises to transform the world as we know it. For equity investors, now is the time to start taking a closer look at these profound trends in order to identify the likely winners.

The transformation is already well underway. This year, the number of connected devices will begin to outnumber humans on the planet, according to Cisco (Display). The cell phone is still the most common connected device, but applications such as automobiles, home appliances and consumer wearables (think Google Glass) are increasingly talking to us and to each other. The growth in the market for sensors that help make these conversations possible is a particularly compelling proposition to us.

Smartphones to Become Communication Hubs

Let’s start with the cell phone. Innovation tends to be highest in this market, in part because of a shorter product cycle—typically nine to 12 months versus more than two years in the auto industry. We believe that the cell phone’s traditional role may change: in the near future, many of today’s typical activities such as talking, messaging and mapping could take place using other devices, including watches, glasses and vehicle heads-up displays. We’d envision the smartphone being more of a hub in this future world than the “do-everything” device it is today.

With smartphones serving as communication hubs, new short-range communication standards such as NFC, Zigbee and Bluetooth low-energy (BLE) will proliferate, helping to knit together these “conversations.” In our view, BLE is most likely to see broadest adoption—it was included in Apple’s iPhone 4S back in 2011 and is supported natively in the latest Android OS release. Semiconductor firms that supply this technology may stand to benefit from its further penetration.

Transforming the Retail Experience

Another opportunity we see in this new technology wave, believe it or not, relates to the traditional—bricks-and-mortar retail. Retailers want to offer a more personalized shopping experience, and greater connectivity is making it possible. For instance, it’s now possible to map indoor locations using technology from Apple, Google and Qualcomm, using Wi-Fi signals and sensors in shoppers’ phones—no more wandering up and down aisles looking for picture frames.

Apple and eBay’s PayPal are also both exploring the use of beacons that detect when a customer is nearby—you can imagine that would be a sought-after technology for traditional retail firms. Neiman Marcus, for example, is piloting an app that connects customers with their favorite sales associates and shopping preferences as soon as they enter a store. Starbucks is another leader in this area: over 10% of all transactions in its US stores are now made with a phone.

The Connected Consumer

As much as any company, Google has been at the forefront in reaping the benefits of a more connected consumer. Just as Amazon reshaped the e-book market with its Kindle e-reader, we think Google will help define the benefits of wearable computing devices with the introduction of Google Glass. While today’s versions may seem relatively primitive, we think we’re only scratching the surface of their potential.

Of course, there are challenges in the transformation into the Internet of Things. Simple bandwidth is an obvious one: there’s not enough to connect all our appliances, cars and bridges together yet. And where do we store all this data? How would we analyze it to make sense of it all? In our view, companies that can answer that last question—turning data into intelligence for business owners—will play a vital role.

There are deeper questions. What about privacy? Who really owns the data? What can it be used for? What should it be used for? All these questions will be debated vigorously, but there’s no arguing that a new era of hyper-connectivity is headed our way.

Investors should be on the lookout for companies embracing this new disruptive force rather than ignoring it. Smaller firms are often the earliest adopters, but as we’ve highlighted above, some of the world’s largest firms are very active in driving the Internet of Things. When assessing a company’s prospects, the most important question we ask is: does management have a vision and business plan for a new world where everything is connected?

Get ready to ride the wave. The rise of the machines is at hand.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.